How I Expect the Market to React to the Fed Announcement and How I am Trading It

The Fed will finish their January meeting today and issue an announcement at 2:00 pm, followed by a press conference from the FOMC Chair, Jay Powell, at 2:30 pm. Powell’s style as Chair has been marked by transparency and openness, and the current deliberations are no exception to that. There have been clear signals from several committee members as to what to expect today but, even so, the financial world will be watching closely.

Traders, analysts, and investors will all be looking for hints in the specific language as to when exactly rates will start to rise, and by how much. Those looking for something sensational, however, will probably be disappointed. Powell is not a surprise kind of guy and is certainly too smart and too considered in his words to say something dumb or inadvertently revealing in the presser.

Much more likely is that today simply confirms what the market feels it already knows; that rate hikes will begin next quarter, with three one quarter percent increases most likely this year. There will be a lot of talk of awareness of the risks of Covid and whatever, but that basic scenario will remain the intended path. So, if what is said would seem to be predictable, what will the market reaction be, and how can it be traded?

The expectation of rate hikes has presumably been what all the selling has been about so far this month, but it is interesting that over the last two days there has been some resistance by the bulls. Monday and Tuesday each appear on the one-day candle chart as candles with “long tails,” indicating a move lower and a strong bounce back at some point in the day. If you compare that to the previous four days’ candles, all of which have a solid bottom to indicate that the market was at its lowest at the close, it appears that the mood is beginning to change.

It seems we are looking at a classic “sell the rumor, buy the fact” pattern, but with a twist. In this case, it has been “sell the early rumor, then buy the later rumor that the fact will turn out a certain way.” Not as snappy as a saying, but a logical conclusion from the price action.

That sounds complicated and brings in the possibility of another, similar patter forming now in miniature. Are traders buying the rumor now and will sell the fact at 2 pm? Maybe, but as a trader, it is easy to overthink these things and get caught up in a “what if” mentality that ultimately stops you from doing anything. After forty years in and around markets, I am all too aware of that, so when I saw Monday’s bounce, I hatched a plan for a trade on Tuesday that would leave me with a protected position in the E-Mini S&P 500 Futures (ES) going into today’s announcement.

The plan was to buy on a dip to around 4300 should it come, with the intention of averaging into a full position on either of two moves. If we bounced off the round number, I would buy on a break of 4320, putting me in at around 4310, then set a stop at around my original entry point. If we moved a bit lower, I would buy again just above 4280 for an average around 4290 and with a stop at around 4270.

Neither way would I be risking a huge amount, but if I saw a run up from my second level in either case, I could take a profit on half my position. Then I would adjust the stop on the remainder to give me a small position with a downside of flat or a small profit and a lot of upside going into today’s Fed announcement.

The second scenario played out: I bought a couple of contracts at 4297 then two more at 4281.25. That left me long of four at an average right around 4290. The anticipated bounce came, allowing me to sell two at 4335, then reset the stop on the remaining two contract position to my original average, around 4290. Here’s how it looks on my chart as I write:

ES minis chart

I have already made money overall, even if I hit my stop following the Fed news. If, on the other hand, ES gains on the announcement, my profit will be significantly more.

The point here is that the best trades don’t come from a singular approach or style. This one involved some fundamental analysis initially that resulted in an idea. That idea only became a trade when the chart setup suggested something. This happens to be in the fast money world of futures, but the same three basic principles can be applied to longer-term, investment trades.

Have a base case, make a plan, and stick to it.

Doing those three things doesn’t guarantee that every trade will be a winner, but it does allow you set up a trade that risks a manageable amount and offers the possibility of ending up with a “free” trade with a big upside. In this case, whatever Jay Powell says today, I will make money, and that’s the way I like it.

Do you want more articles and analysis like this? If you are familiar with Martin’s work, you will know that he brings a unique perspective to markets and actionable ideas based on that perspective. In addition to writing here, Martin also writes a free newsletter with in-depth analysis and trade ideas focused on just one, long-time underperforming sector that is bouncing fast. To find out more and sign up for the free newsletter, just click here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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